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How Vale’s Focus on Costs Could Improve Profitability in Coal

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Coal production increases

Vale SA’s (VALE) coal production for 2Q16 rose 3.8% QoQ (quarter-over-quarter) to reach 2.8 million tons. The volumes for metallurgical coal were lower in 2Q16 due to the roof fall at Carborough in May 2016. Thermal coal sales, on the other hand, were higher in 2Q16 due to the sales of stockpiles from previous quarters, which accumulated due to the ramp-up of the Nacala Logistics Corridor.

To read more about Vale’s coal operations, read Market Realist’s overview of the company, Vale SA: The iron ore giant deconstructed.

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Profitability has fallen

Vale’s adjusted EBITDA (earnings before interest, tax, depreciation, and amortization) was -$110 million in 2Q16 compared to -$93 million in 1Q16. The sequential fall in EBITDA was mainly due to geological instability issues at Carborough Downs in 2Q16.

Vale’s realized prices were also impacted negatively in 2Q16 due to lagging sales contracts. Vale’s management expects to capture this price upside in 3Q16 as lagging realizations come due.

Focus on costs continues

During Vale’s 2Q16 earnings call, the company maintained its focus on reducing costs, increasing profitability, and ramping up Nacala. Its cost performance in coal was positively impacted by the cost declines in Mozambique. Management mentioned during the call that production cost per ton in Mozambique for coal transported through the Nacala Logistic Corridor fell ~40% sequentially. These gains should continue in the coming quarters due to the ramp-up of Nacala.

Increased supply and weak demand have caused many US coal companies (QQQ) to file for bankruptcy. Other coal producers (KOL) such as Peabody Energy (BTU), Arch Coal (ACI), and Cloud Peak Energy (CLD) are also working to reduce costs to weather this downturn.

Cloud Peak Energy forms 3.0% of the SPDR Metals and Mining ETF (XME). XME gives exposure to the diversified metals and mining space. BTU forms 4.8% of the VanEck Vectors Coal ETF (KOL).

In the next part of this series, we’ll see how Vale’s base metals division is doing.

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